“While Baby Boomers tend to be satisfied with their current housing situation, younger generations are still struggling to determine whether to rent or purchase a home, largely due to lack of supply and affordability constraints.” David Brickman, CEO of Freddie Mac
Changes to Credit Scoring
Lenders tend to be fussy about their money. When they lend it out, they want a high level of confidence that they will get it back.
A century or so ago this could be a hit- or-miss situation. Lending was pretty much the province of banks. Banks were local and typically knew their customers personally and how they measured up to the “Cs” of lending— Character, Capacity, Capital, and Collateral. That personal knowledge didn’t always work out and as early as the 1860s, merchants were compiling and sharing lists of bad credit risks with other local businesses.
Credit bureaus began to emerge in the early part of the 20th Century and the major ones who survive today didn’t all start out with that business model. Equifax was founded in 1899 as the Retail Credit Company, primarily tracking corporate credit. TransUnion came on the scene in 1968 as a holding company of Union Tank Car and segued into credit reporting after acquiring some small regional and big city credit bureaus. The youngest of the bunch, Experian, was founded in England in 1980 and later bought TRW, a U.S. credit bureau.
As recently as the late 1970s, credit reporting was the Wild West. Nerdwallet describes the process in the “old days.” “There were many credit bureaus, and a rep would call or visit stores asking about a given customer to determine if he was paying his bills. It was quantitative but not exact. When asked, a merchant would not respond, “Yes, he pays 87.5% of his bills on time with 45.6% of the balance paid off each time.” It would be closer to, “He pays on time, usually. Oh, and he likes cigars.”
Even worse, the bureaus didn’t collect the same information, there were no rules about how long information could be stored, many lenders didn’t bother to report, and errors were rampant. In 1970 Congress passed the Fair Credit Reporting Act that directed financial regulators to set guidelines, but this is still a work in progress.
In the meantime, lending was going national. “Charge cards” had been around for years but were generally issued by retail establishments to their own customers. Then in 1966, BankAmericard came out with the first licensed general-purpose credit card. Their use promptly exploded. So did lender losses.
Something Needed to Be Done I
Fair Isaac Corporation (FICO) was I founded in 1952 to develop business solutions using math and those new-fangled computers. Early on they recognized the need for systemizing credit reporting. The idea was to use algorithms to predict consumer behavior by comparing facts about that consumer to statistical averages. This can only be done accurately when data about many people are put into the system, something that would not have been possible before the invention of computers.
FICO wasn’t the only company pursuing this goal. Lenders were developing their own scoring systems, but they were clunky and could vary drastically from one lender to another. They also didn’t eliminate human emotion and judgment.
Success took a long while, but in 1989 FICO introduced its first credit scoring model. Its success was assured six years later when it was endorsed for use in Fannie Mae and Freddie Mac lending.
How Does it Work?
Credit scores don’t replace credit reports, in fact, they are based on them, taking the totality of a borrower’s management of debt and reducing it to a single number. This information includes the number and type of the consumer’s open credit accounts, how long the consumer has been utilizing credit, and the amount of available credit that is being used. And of course, the consumer’s history of paying bills.
Not all of these variables are treated equally by scoring models. The most influential part of a credit score is payment history. This goes deeper than whether bills are paid on time, but how late were the late payments, how recent and how frequently did missed payments occur? The scoring also includes any bankruptcies, charge offs or collection activity.
Heavyweight is also given to the amount owed, not as a raw number but as a percentage of the consumer’s available credit. A mix of credit accounts that are “maxed out” will lower the score. Consumers are advised to keep debt below 30% of their credit limits.
How long a consumer has been using credit and managing it well is another important category. It’s good to have at least a few accounts (but not too many) and variety is also important. Lenders want to see that a consumer has used different types of credit without problems.
Scoring also looks (and not favorably) on a lot of new accounts and on indications the subject is applying for additional credit. Most types of inquiries, however, won’t affect a score.
Well Kept Secret
While credit scoring has now been in wide use for twenty-five years, it was a while before most consumers knew the measure existed. When discussions of scores became widespread, most consumers weren’t told if they had a score or what it might be. Even after Congress passed a law making free credit reports available, access to scores, which were proprietary, remained firmly closed.
In 2001 FICO began allowing consumers to see their score and how it was calculated—for a price. The three major credit bureaus, Equifax, Experian, and TransUnion were soon given permission to release scores to their customers, which they did, using their own branded scores based on FICO models—again at a price. In 2013, FICO began its Open Access program which allowed lenders to provide scores to individuals.
It was Discover Card that first broke the barrier, dangling a free credit score reveal to its customers as a sales gambit. They were soon followed by other credit card companies, banks, and credit unions. Today, almost all adults are aware scores exist, how they are produced, and a recent survey found all but about 13% know their current number. This access, however, has its own drawbacks.
BUY A LITTLE HISTORY
If owning a Frank Lloyd Wright home is on your bucket list, you are in luck. There are eight of them currently for sale. Prices range from $175,000 to just shy of $10 million and the styles pretty much cover the gamut of Wright’s design evolution. Most are located in the Chicago area, but one is in Texas and the most expensive one, which Wright designed for his son, is in Phoenix.
Not all of them started out as houses. One was originally an elementary school, another was a playhouse for another school, and yet another was designed as a horse stable on a large estate. Megan Barber, Curbed
Too Many Answers
If you are one of millions who now get free credit score updates, you may have noticed the free score you get from your credit card company is different from the one provided when you are approved or denied an auto loan or a personal line of credit. You might be puzzled by variations from month-to-month or wondered why your apparently flawless credit report isn’t reflected in an equally stellar credit number.
Buckle up, here is the rest of the story.
First, while FICO and its scores dominate credit scoring—they claim a 90% market share—they aren’t the only game in town. The three major bureaus each produce scores from the data in their files (generally using FICO models). The three also jointly own Van- tageScore, FICO’S main competition.
If you pull your free credit reports from all three bureaus at the same time, you will begin to see why scores differ. So do the reports upon which they are based. The bureaus collect different data, collect it on a different timeframe, and even from different sources. Some creditors report to only one or two bureaus, very few report to all three. So, there is a difference even before the mistakes last time round, mistakes that ultimately cost them billions to settle malfeasance lawsuits.
BUILDING THE WAY TO RECOVERY
Home building might do more than end the housing shortage, it might lead the way to a post-pandemic recovery as well. Building an average single-family home creates 2.90 full-time equivalent (FTE) jobs, generates $189,000 in wages and salaries and $138,700 in profits, much going to small sub-contractors, and $110,957 in taxes.
While 1.71 of the FTE jobs are in construction, they also include jobs in industries that produce, transport, store, and sell equipment and materials to professionals in architecture, engineering, law, and real estate. Paul Emrath, National Association of Home Builders
This time lenders are acting fast. Even before the first unemployment numbers (and thus far they have been staggering) came out, Fannie, Freddie, and Ginnie Mae (it manages FHA/VA/ USDA loans) ordered their servicers to offer “forbearance”—a suspension or reduction of monthly payments—to all those affected by the virus. (Forbearance is not forgiveness. Check with your lender, first, as it may have some negative consequences.) Borrowers are responding proactively, requesting help early, unlike in 2008 when they waited until their loans were badly in arrears.
Congress also responded with $2 billion in stimulus funds and expanded unemployment benefits which, Freddie Mac says, should insulate home prices against 2008 style declines. The Federal Reserve has been quick to shore up securities markets, including those for mortgages, stabilizing sales and keeping rates low.
Help From New Technology
Technology is playing a major role as well. Lenders have made it possible to apply, process, and all but close a loan digitally and are working out the details for e-closings. Real estate agents have performed similar magic with virtual tours.
The End of the Story?
We know how the housing crisis and Great Recession ended. Employment turned around after 25 straight months of losses, home sales and residential construction have never quite reached pre-crisis levels, but there are multiple structural reasons in each case. Home prices bottomed out in the winter of 2012 and were back above their previous peaks in most places five years later. Credit tightened and borrowers paid attention to their risk profiles. Consequentially, the quality of today’s loans is exponentially higher.
What will be the outcome this time? Within weeks of the beginning of the current crisis, there were a slew of forecasts from all of those who do such things. Most of the analysts admitted they were in uncharted territory but also stressed what we have said here; the economy going into the crises was strong, housing was even stronger, and while it pushed the U.S into the last recession, it might be just the ticket to pull it out. The National Association of Home Builders made an especially strong case for this with its statistics, featured elsewhere on these pages, on how home building creates jobs.
In March, Freddie Mac had predicted a 45% decline in home sales for the 2nd quarter, but it was actually the highest level since 2005, just before the Great Recession. Go figure!
DRIVE THRU CLOSING
Three components of real estate closings have always required person- to-person contact, appraisals, notarization, and recording. The pandemic has the potential to disrupt all three. Lenders quickly loosened requirements for using exterior only appraisals and data driven automatic valuations. Now title companies and escrow agents are being creative. One closing took place in a parking lot in Gahanna, Ohio; the buyers in one car, sellers in another, the real estate agent in a third in case her advice was needed. Escrow agents circulated among the cars to get the required IDs and signatures. With many county offices closed, recordation may still be an issue. The Columbus Dispatch and Black Knight
So, while things are scary and much about COVID-19 is still unknown, we know that the current crisis is coming at a time when both the housing sector and the entire economy were unusually well prepared. The economic response has been swift and based on hard-won experience. If the virus itself can be managed and/or appropriate adaptions made to our home and work lives, then NAR Chief Economist Lawrence Yun may be right. About a month into the crisis he said, “Home prices will remain stable because of a pandemic-induced reduction in inventory coupled with less immediate concerns over foreclosures.”
In reality, it is too early to know how this will all turn out, but forecasters predict hopefully, that the worse effects of the pandemic will be short lived with a rapid recovery to follow. Let’s hope they’re right.